More On Legal & Compliancefrom The Advisor's Professional Library
- Conducting Due Diligence of Sub-Advisors and Third-Party Advisors Engaging in due-diligence of sub-advisors isnt just a recommended best practice it is part of the fiduciary obligation to a client. An RIA should be extremely reluctant to enter a relationship with a sub-advisor who claims the firms strategy is proprietary.
- Code of Ethics Rule The Code of Ethics Rule, found in Rule 204A-1, uses severe consequences for violation to help ensure investment advisors will do the right thing.
Among recent actions by the SEC were charges against a Texas couple for fraud in a Visa scheme and against China-based executives for fraud and insider trading; an asset freeze against a Las Vegas firm for a Ponzi scheme preying on residents of Japan; charges against a New Jersey firm and one of its founding partners for failed audits; charges against a south Florida woman for a Ponzi scheme that targeted Colombian-Americans; against three auditors for audit failures in a gatekeeper crackdown; and against an Omaha advisory firm and its owner for best execution failures.
In addition, FINRA sought a cease-and-desist order in a case of fraud and stock manipulation.
SEC Halts Texas-Based U.S. Residency Scam
The SEC has charged Marco and Bebe Ramirez, a Texas husband and wife, with fraud after they concocted a scheme to steal funds from foreign investors while passing it off as an investment opportunity to create U.S. jobs and provide a path to U.S. residency. In addition, the couple’s assets — and those of three companies they own, USA Now LLC, USA Now Energy Capital Group and Now Co. Loan Services — have been frozen, so that they can’t bring in or spend further investor money.
The agency said that the Ramirezes and their three companies have fraudulently raised at least $5 million from investors under the guise of soliciting investments as part of the EB-5 Immigrant Investor Pilot Program, which allows foreign investors to earn conditional visas and eventually green cards. To do so, they must make investments in U.S. economic development projects that will create or preserve a minimum number of jobs for U.S. workers.
In 2010, the couple tried to register USA Now with the U.S. Citizenship and Immigration Services (USCIS) as an EB-5 regional center that would accept and direct investments from foreign investors into investment opportunities that would purportedly satisfy the EB-5 visa requirements. But they and their employees didn’t wait for the USCIS decision, soliciting investors and claiming that their money would be placed in escrow till approval was granted.
The Ramirezes didn’t bother to put the money they raised in escrow, or even to invest it for the people they bilked. Instead they funneled it to other undisclosed businesses, including a Cajun-themed restaurant, sometimes the same day the money came in, as well as using it for personal expenses and to settle a lawsuit that had nothing to do with the scheme. In at least one case, they used new investor funds to make Ponzi-like payments to an existing investor.
The SEC seeks various relief, including preliminary and permanent injunctions, disgorgement of ill-gotten gains with prejudgment interest and financial penalties.
SEC Fines Advisor, Firm for Pushing High-Cost Share Classes
In what one expert called a groundbreaking move, the SEC used a best-execution charge to hit a firm for offering its clients A shares instead of lower-cost institutional shares and pocketing the fees through its brokerage firm.
Manarin Investment Counsel and Roland Manarin were charged by the SEC with violating their best execution obligation by consistently steering clients into higher-cost shares of the three mutual funds they managed, even though cheaper shares in those funds were available. That resulted in clients paying avoidable fees, which were passed through to a brokerage firm owned by Manarin in a way not disclosed to investors.
The SEC said that Manarin Investment Counsel provides investment advice to a mutual fund called Lifetime Achievement Fund (LAF), and to two private funds called Pyramid I Limited Partnership and Pyramid II Limited Partnership. As funds of funds, they invest their assets principally in the shares of various mutual funds.
From 2000 to 2010, Manarin and his firm steered fund clients to invest in class A shares of these funds when instead they could have owned lower-cost institutional shares in the same mutual funds. The A shares meant the clients paid ongoing 12b-1 fees that could often have been avoided with I shares.
The fees were passed through to Manarin’s broker-dealer Manarin Securities Corp. Although his brokerage firm eventually refunded 12b-1 fees paid by LAF, it did not refund fees to the Pyramid funds. From June 2000 to October 2010, Manarin Securities Corp. received approximately $685,000 in 12b-1 fees from mutual funds in which the Pyramid funds could have purchased institutional shares.
Without admitting or denying the SEC’s charges, Manarin and his firms agreed to pay more than $1 million to settle them; they will pay disgorgement of $685,007 and prejudgment interest of $267,742. Manarin himself agreed to pay a $100,000 penalty. He and his firms also consented to censures and cease-and-desist orders.
Clipperman Compliance Services commented on the SEC’s action, pointing out that “The funds' disclosure statements indicated that the a firm's affiliate would receive 12b-1 fees on the investments, but the SEC faulted the firm for failing to disclose that it could purchase the institutional share classes of the same funds without 12b-1 fees.”
As a result, the firm suggested, “This case appears to enter new regulatory territory. The SEC could have brought this action as a classic conflict of interest case about an affiliate receiving compensation. However, the SEC went further, asserting that an advisor has a best execution obligation to purchase the lowest-cost share class available. This follows a line of cases that FINRA brought several years ago where brokers were charged with suitability violations for buying class B shares (no front-end load but higher fees) instead of class A shares. Could the SEC take this a step further and assert that advisors must find the lowest cost fund that has a similar investment mandate?”
China-Based Education Execs Charged by SEC With Fraud, Insider Trading
Chan Tze Ngon, former CEO and chairman of the board of ChinaCast Education Corp., and Jiang Xiangyuan, ChinaCast’s former president for operations in China, were charged by the SEC, the former with stealing tens of millions of dollars from investors in a U.S. IPO and the latter with illegally dumping his company stock after he helped steal valuable company assets.
According to the SEC, Chan transferred $41 million out of the $43.8 million raised from investors to a purported subsidiary in which he secretly held a controlling 50% ownership stake. From there, he moved money to another entity outside ChinaCast’s control. He also secretly pledged $30.4 million of ChinaCast’s cash deposits to secure the debts of entities unrelated to ChinaCast. Of course he failed to disclose any of this in the reports he signed and filed with the SEC.
Jiang, for his part, was charged with avoiding more than $200,000 in losses by illegally selling approximately 50,000 ChinaCast shares after participating in the ownership transfer of one of company’s revenue-generating colleges before it was publicly disclosed by a new management team.
Before the two frauds were discovered, ChinaCast had a market cap of more than $200 million. After a new management team removed the two and made their misdeeds public, the value dropped to less than $5 million.
The SEC, whose investigation is continuing, is seeking disgorgement of ill-gotten gains plus prejudgment interest, financial penalties, permanent injunctions, and officer-and-director bars.
Firm Owner Accused of Bill-Collection Ruse to Pay Alimony, Child Support
The SEC announced an emergency asset freeze against a Las Vegas-based firm and its sole owner, who were charged with setting up a Ponzi scheme involving thousands of investors living primarily in Japan.
Edwin Fujinaga and his company MRI International raised more than $800 million from investors, telling them that their money would buy accounts, at a discount, from U.S. medical providers with outstanding balances to collect from insurance companies. The discount would provide investor profits when Fujinaga and his firm would collect the full outstanding balances.
No such collection ever took place; in fact, no accounts were ever bought. Instead, investor money was used to pay funds due to earlier investors in a Ponzi setup — as well as to buy luxury cars and pay Fujinaga’s credit card bills, alimony and child support.
The SEC was granted a temporary restraining order, asset freeze, and other emergency relief against MRI, Fujinaga and CSA Service Center, which is a company controlled by Fujinaga that is the nominal owner of homes that he occupies in Las Vegas, Beverly Hills and Hawaii. CSA Service Center is named as a relief defendant for the purposes of recovering any ill-gotten assets.
The SEC’s investigation is continuing. Meanwhile, it seeks disgorgement of ill-gotten gains, financial penalties, permanent injunctions and other emergency relief.
New Jersey Firm, Founding Partner Charged by SEC in Failed Audits
New Jersey-based audit firm Patrizio & Zhao (P&Z) and one of its founding partners, Xinggeng (John) Zhao, who is head of the firm’s China practice, were charged by the SEC for the part they played in botching the audits of China-based Keyuan Petrochemicals, which failed to disclose related party transactions by its CEO and others. The latter firm was charged by the SEC earlier in the year for accounting and disclosure violations.
P&Z, which is registered with the Public Company Accounting Oversight Board (PCAOB), conducted audits and interim reviews during the periods when Keyuan failed to disclose the material related party transactions, and did so with Zhao acting as the engagement partner.
P&Z’s audit workpapers and other documents show many of the same types of related party transactions that Keyuan failed to disclose. Zhao determined that related party transactions were an audit risk area. He reviewed audit documentation reflecting that Keyuan was engaged in such transactions, but went ahead and approved the issuance of unqualified audit opinions, as well as interim review reports on Keyuan’s financial statements that violated U.S. Generally Accepted Accounting Principles by failing to include the disclosure of material related party transactions.
Zhao also committed other significant audit documentation violations.
Without admitting or denying the SEC’s findings, P&Z and Zhao agreed to settle the charges. They will be prohibited from practicing as an accountant on behalf of any publicly traded company or other entity regulated by the SEC, and P&Z is required to pay a $30,000 penalty.
Woman Charged by SEC in Bail Bond Scheme
The SEC charged Jenny Coplan, a woman living in south Florida, with defrauding investors in a Ponzi scheme and affinity fraud that targeted the local Colombian-American community and involved purported investments in immigration bail bonds. She also faces parallel criminal charges.
Coplan told investors that her company, Immigration General Services, operated through an investment broker that would invest the funds she raised in immigration bail bonds and turn a profit. She promised interest payments ranging from 60% to 108% per year, and assured investors their money was FDIC insured and therefore safe.
But Coplan paid early investors with the proceeds from later ones, and in the meantime never invested anything but stole approximately $878,000 of investor money for her own personal use. She created fictitious investor statements to hide her actions, and even emailed one investor two fake FDIC statements reflecting insured balances of $107,000 and $250,000.
When things started to come apart in 2011, she blamed the nonexistent investment broker for the delay in interest payments to investors, claiming that the broker held investor funds to cover deficiencies because she had failed to meet certain monthly investment quotas.
Even though Immigration General Services had virtually no funds in its bank accounts and was unable to honor investors’ increasing redemption requests, she tried later that year to cover it up, issuing bad checks that were supposedly investor profits. She even managed to raise another $578,000 from new investors, thanks to her lies, before the scheme collapsed entirely.
The SEC seeks disgorgement of ill-gotten gains, financial penalties and permanent injunctions.
SEC Gatekeeper Crackdown Nabs Three Auditors
Three auditors were charged by the SEC in the most recent action taken in “Operation Broken Gate,” the pursuit by the agency of gatekeepers who fail in their duties.
Malcolm Pollard, who practices in Erie, Pa., and Wilfred Hanson and John Kinross-Kennedy, who live in the Irvine, Calif., area, were charged with violating federal securities laws or failing to comply with U.S. auditing standards during their audits and reviews of financial statements for publicly traded companies.
Pollard and his firm, according to the agency, engaged in improper professional conduct while auditing three companies that are empty shells or in the developmental stages. The companies’ public stock is quoted on the Over-the-Counter Bulletin Board, and the audits conducted by Pollard and his firm failed to include evidence of procedures performed or conclusions reached.In addition, they failed to retain required documentation, perform the required engagement quality reviews, and consider fraud risks and obtain written management representations. But Pollard and his firm nevertheless claimed in each audit report to have conducted the audits in accordance with Public Company Accounting Oversight Board (PCAOB) standards.
The SEC said that Kinross-Kennedy has been the independent accountant for as many as 23 public companies since 2009. The agency found significant deficiencies in six of Kinross-Kennedy’s audit engagements, and failures to obtain engagement quality reviews (EQRs) for more than 30 other audit engagements. Kinross-Kennedy falsely represented that he conducted his audits in accordance with PCAOB standards.
Hanson conducted EQRs for five of Kinross-Kennedy’s audits, but was not competent to serve as the engagement quality reviewer; he failed to exercise due professional care and also failed to conduct multiple EQRs in accordance with PCAOB standards.
Pollard and Hanson agreed, without admitting or denying the charges, to settle the respective actions against them and will be prohibited from practicing as an accountant on behalf of any publicly traded company or other entity regulated by the SEC. Kinross-Kennedy is fighting the charges before an administrative law judge at the agency.
FINRA Files for Cease-and-Desist Order on Fraud, Stock Manipulation
FINRA filed for a temporary cease-and-desist order against John Carris Investments, LLC (JCI) and its CEO, George Carris, to stop the firm’s solicitations of customers to buy shares of Fibrocell Science, Inc. stock in the absence of proper disclosures.
According to FINRA, during May of 2013, JCI pushed its customers to buy Fibrocell stock without disclosing that at the same time Carris and another firm principal were selling their shares. In an amended complaint, FINRA also charged JCI, Carris, and five other firm principals with additional violations, alleging that that while JCI acted as a placement agent for Fibrocell, Carris and the firm pushed up the stock price with prearranged trades and unauthorized purchases of the stock in customer accounts.
Carris and JCI were also charged with the fraudulent sale of stock and notes in its parent company, Invictus Capital, by not disclosing its poor financial condition. Instead, FINRA said that early investors were paid dividends that came from new sales of Invictus stock, and that neither JCI nor Carris had reasonable grounds to expect that investors would actually make money on the stock.
In March of 2013, Invictus Capital defaulted on $2 million in Invictus notes sold to early JCI customers and said it might have to use the proceeds from its ongoing offering to make repayments. But JCI has continued to solicit new Invictus investments despite its complete unsuitability.
FINRA also said that JCI falsified documents that hid the fact that Carris used firm funds to pay for such personal expenses as tattoos, pet care and a motorcycle, while failing to pay hundreds of thousands of dollars in employee payroll taxes to the U.S. Treasury.
Check out SEC Awards $14 Million to Whistleblower on ThinkAdvisor.